How Fund NAV Is Set and Why Secondaries Price Off It

Introduction

Secondary buyers spend much of their diligence doubting a fund's net asset value (NAV), and then quote every bid as a percentage of it. The International Private Equity and Venture Capital Valuation (IPEV) Board acknowledges the tension in its own guidelines: secondary prices are negotiated, usually set off a NAV from an earlier date, and include the buyer's required return, so they are not simply fair value. Yet NAV is the one number that exists for every fund, sits in every seller's files, and is built on a common basis.

The habit makes sense once the number's construction is clear. A general partner (GP) marks each portfolio company to fair value every quarter, under accounting standards, a valuation policy, and a year-end audit, and the administrator turns those marks into each limited partner's (LP's) capital account. The result is careful, slow, and self-reported, and those qualities are what the discount to NAV prices.

An Exit Price at the Measurement Date

US generally accepted accounting principles (GAAP), through Accounting Standards Codification (ASC) Topic 820, and International Financial Reporting Standards, through IFRS 13, define fair value the same way: the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date, as the IFRS Foundation's summary of IFRS 13 puts it, an exit price. Three phrases in that definition do most of the work:

Investment Company Accounting: One Line per Company

A buyout fund that owns all of a manufacturer does not consolidate it. Under ASC 946, the US GAAP topic for investment companies, a fund with the defining characteristics (pooled investor capital, investment management, and returns sought only from income and capital appreciation) carries each investment at fair value, controlling stakes included, with changes in value run through its statement of operations. IFRS reached the same place in October 2012 with the investment entity exception in IFRS 10.

The fund's balance sheet is therefore a list of fair values plus cash, less liabilities such as a drawn subscription line. What remains is fund NAV. Each LP's share appears net of the GP's accrued carried interest, as the article on fees, carry, and the waterfall explains, on the quarterly capital account statement that the fund administrator prepares.

Level 3 and the Fair Value Hierarchy

Both standards rank fair value measurements by the inputs behind them. Level 1 uses quoted prices in active markets for identical assets, such as a listed stake after an IPO. Level 2 uses other observable inputs, such as prices for similar assets. Level 3 uses unobservable inputs: the manager's own assumptions.

Level 3 Fair Value Measurement

A fair value estimate that relies on significant unobservable inputs, such as a manager's chosen comparable multiples, discount rates, or cash-flow forecasts, because no quoted or observable price exists for the asset. Private equity and private credit holdings are generally Level 3, so their reported values are calibrated models rather than prices.

Level 3 does not mean unreliable; it means the number rests on judgment, which is why the hierarchy is mainly a disclosure device. A fund's audited statements show which holdings sit in Level 3 and describe the techniques and principal inputs behind them. Every multiple built on NAV, such as residual value and total value to paid-in capital (RVPI and TVPI), inherits that judgment.

The 2025 IPEV Valuation Guidelines group the permitted techniques into a market approach (multiples, industry benchmarks, available market prices), an income approach (discounted cash flow, or DCF), and a replacement cost approach (net assets), with the price of a recent investment used to calibrate them. Practice leans on the first. The UK Financial Conduct Authority (FCA), in its March 2025 review of private market valuation practices across 36 firms, found that most used the market approach as their primary private equity method, half of them exclusively, while infrastructure equity managers relied primarily on the income approach.

Market Multiples and the Calibrated Discount

The market approach applies a multiple drawn from comparable listed companies to the company's earnings, usually EBITDA, to reach an enterprise value, then deducts net debt and allocates the remaining equity among the securities in the capital structure. The difficult question is how far the private company should trade from its public peers, and calibration answers it with the one market price the GP has for certain: what the fund paid.

Calibration (Private Equity Valuation)

The practice of setting a valuation model's inputs so that, at the investment date, the model reproduces the price actually paid. The implied adjustment, such as a discount to comparable company multiples, is then carried forward and reassessed at each later measurement date, so later marks move with market inputs rather than drifting from the original evidence.

The table follows one illustrative holding from entry to its first anniversary.

EBITDA grew 10%, yet the mark fell 2%, because the comparables de-rated by about 11.5%. Calibration is how public market moves reach a private mark, but only as quickly as the chosen peers move and only if the calibrated discount is not quietly narrowed to offset them. Both choices sit with the GP, so reviewers and buyers ask about them first.

DCF and the Price of a Recent Investment

The income approach discounts projected cash flows at a rate that can itself be calibrated, by solving for the return implied by the entry price and then adjusting it for market changes. It dominates where cash flows are contracted, as in infrastructure, and elsewhere serves mainly as a cross-check on multiples.

The price of a recent investment gets careful treatment. An orderly deal generally represents fair value on its date, and the guidelines accept it as a starting point for later quarters, but they call it "not a default": fair value must be re-estimated at every measurement date. A round with preferential rights, a strategic investor, or a rescue financing may not be representative, and after a market dislocation a price agreed beforehand may deserve little weight, a point many 2021 software take-privates tested as SaaS multiples reset. The illiquidity and control questions behind these adjustments belong to private company valuation.

Credit Funds: Yield Analysis, Not Par

For loans without a traded price, the guidelines call for a yield analysis that weighs credit quality, coupon, and term, and state that par or amortized cost is not automatically fair value, even when the borrower's enterprise value covers the debt. Suppose a floating-rate loan was made at a spread of 5.5 percentage points and comparable loans now require 6.5: with about three and a half years of expected life, its fair value falls roughly three points below par, before any change in the borrower's credit. Base-rate moves pass through the coupon; spread and default risk are where credit marks move.

A quarterly mark passes through a chain of review before it reaches an LP's statement, and each link is a place where a buyer can test it:

Only the last step is an external audit, so the independence of the earlier reviews carries most of the weight.

The Valuation Policy and Committee

The valuation policy fixes which techniques apply to which assets, how peer sets and discounts are chosen, and what events trigger a revaluation between quarters. Many adopt the IPEV Guidelines as their framework; the 2025 edition, published in December 2025, applies to quarterly periods beginning on or after April 1, 2026. The policy is only as strong as the valuation committee applying it. The FCA found that every firm it examined in depth had one, but in some, senior investment professionals were voting members, which the regulator said it would follow up.

The Auditor and the Year-End Mark

Quarterly marks are generally unaudited. For SEC-registered advisers relying on the custody rule's audit provision, the annual audit has a deadline: financial statements prepared under GAAP, audited by an accountant registered with and inspected by the Public Company Accounting Oversight Board (PCAOB), distributed to investors within 120 days of fiscal year-end. An auditor tests whether the method was applied properly and the result falls within a reasonable range, not whether the mark is the price a buyer would pay.

Third-Party Valuation Agents

Many GPs add an outside valuation adviser, such as Houlihan Lokey's portfolio valuation practice, either to value holdings independently or to review the GP's marks. The FCA found that most firms it surveyed used one, a full independent valuation being the most common service, while warning that independence may be limited when the provider depends on the manager's fees.

Quarterly Marks and a Reference Date That Ages

The FCA found the industry had converged on quarterly valuation cycles. Add the reporting lag and an LP sale runs on old information by design. Take an illustrative sale referenced to a December 31 NAV: year-end statements can arrive in late April, final bids come in June, and transfers close at the end of September once the underlying GPs consent. By closing, the reference NAV is nine months old, and two newer quarters of marks exist.

A NAV roll-forward adjusts the price for calls and distributions after the reference date, but interim valuation changes typically belong to the buyer, so the bid has to anticipate them. Hence the IPEV Guidelines' observation that secondary pricing is generally based on a NAV from an earlier point in time.

Smoothing: What the Evidence Shows

Marks also move less than markets. Using the full history of 761 fund investments made by the California Public Employees' Retirement System (CalPERS), Tim Jenkinson, Miguel Sousa, and Rüdiger Stucke found that valuations were conservative and smoothed relative to public markets, understating subsequent distributions by about 35% on average, and jumped in the fourth quarter, when funds are normally audited. The exception was fundraising: valuations and reported returns were inflated while follow-on funds were raised, then gradually reversed.

2022 showed the pattern at market scale. Bain's 2023 Global Private Equity Report noted that the S&P 500 closed the year down 19% and the MSCI Europe Index down 17%, while the private equity holdings of Blackstone, KKR, Apollo, and Carlyle all held up better, two of the four posting gains. The FCA's case studies point to some of the mechanics:

Smoothing also lifts the private share of an LP's portfolio when public markets fall faster than marks, one source of the denominator effect.

Regulatory Attention: The FCA Review and SEC Examinations

The FCA's review, covering firms that manage about £3 trillion of private assets, centered on conflicts of interest. Marks set fees in open-ended funds that charge on NAV, support fundraising on unrealized performance, set transfer prices when assets move between vehicles, and in a few firms feed investment staff pay. They also drive loan-to-value tests when a fund borrows against its portfolio, a conflict most firms had not documented and one that matters for NAV lending.

The US Securities and Exchange Commission (SEC) has long examined the same risk. A June 2020 staff risk alert described private fund advisers that did not value assets according to their disclosed valuation process, in some cases overcharging management fees and carried interest on overvalued holdings. The examination priorities for fiscal 2026 list valuation among the core compliance areas examiners review and flag it for advisers new to private funds.

A Common Unit That Needs No GP Cooperation

An LP portfolio can hold interests in dozens or hundreds of funds, each with its own GP, vintage, and reporting calendar. NAV is the one figure available for all of them without asking anyone: the seller holds its own capital account statements, and the ILPA model LPA lets an LP disclose the value of its interest even when portfolio detail needs the GP's consent, as the limited partnership agreement article shows. It rests on one accounting basis across managers, a roll-forward can carry it to any later date, and it is the number on the seller's books.

NAV Practical Expedient

A provision of ASC 820 that lets an investor measure an interest in a fund within the scope of ASC 946 at the NAV the fund reports, provided the fund's own investments are measured at fair value as of the reporting date. It is why LPs commonly carry fund interests at reported NAV.

A sale at 85% of NAV therefore shows up as a realized loss against book value on the seller's statements, one reason sellers anchor to NAV. A buyer builds its own cash-flow view of each fund and its largest companies, then expresses the result as a percentage of NAV so that bids compare, as how secondary buyers assess a fund interest sets out. The accounting does not follow the trade automatically: the IPEV Guidelines state that a purchase at a discount does not by itself mean the underlying fair values need adjusting, though an orderly secondary trade in the same fund is one input a valuer of that interest must consider.

What a Discount to NAV Encodes

A discount is not one number but the sum of several answers:

2022 shows the components at work. Jefferies' review of the 2022 secondary market put average LP portfolio pricing at 81% of NAV, down 1,100 basis points from 2021, with pricing falling through the year as public and private valuations diverged. Jefferies attributed the drop partly to perceived inflated private valuations and expected exit delays, and in the second half buyers rarely bid 90% or more of NAV for any buyout fund. The marks had not yet moved, so the discount moved for them. How unfunded commitments and interim cash flows turn a percentage into closing cash is worked through in pricing LP interests.

The components are not equally within the seller's reach. The buyer's return target is set by its cost of capital and by competition among bidders, and unfunded exposure is fixed once the portfolio is chosen. Staleness and credibility can be worked on: a data room with the latest quarter's marks beside the reference NAV, realizations set against prior marks, the GP's valuation policy, and any third-party reviews narrows the part of the discount that reflects doubt rather than price. NAV stays the unit because nothing else is common to every fund; the advisor's job is to make it as current and believable as the evidence allows.